How much protection can you truly expect to receive from a Corporation or Limited Liability Company as a real estate investor? If you listen to some purveyors of asset protection tools the answer is complete protection. If you ask an attorney the answer is “it depends.” Many investors are frustrated by the attorney answer and view it as an attorney’s lack of experience or understanding or real estate investing. Even though I am an attorney and share in this belief, in some instances, the facts and circumstances cannot be so easily dismissed.
Entities fall into two asset protection categories – liability protection and asset protection. An entity that will protect the owner from the liabilities associated with his business is considered one that provides liability protection. An entity that will step beyond just protecting the owner from his business and will protect the business from the owner personal liabilities is considered one that provides asset protection. To make is simple – corporations provide liability protection but not asset protection (Nevada is the exception) and limited liability entities provide asset protection (another caveat – depends on the state).
So, as an active real estate investor who is rehabbing property, wholesaling, or engaging in any other activity you might be thinking that if you set up any form of business entity you are protected. Think again. The protections offered by entities are great and will protect you in most circumstances except the following:
- the entity lacks proper operating agreements or the agreements are insubstantial (veil piercing argument);
- the entity did not have an existence separate from its owners (veil piercing argument); or
- the owner’s conduct caused the injury or loss complained of (tort argument)
The first two exceptions can easily be addressed by having good business documents relative to your business activity, up to date minutes, separate books and bank accounts, signing in your representative capacity, etc. The last exception is the one most people do not understand. Remember the asset protection guru told you that if you set up an entity you are completely protected. Not so if you are the one who is alleged to have negligently or intentionally caused harm to someone. Take for example the case where a disgruntled buyer alleges he purchased a defective home from your company that you personally rehabbed. In this situation the company and the owner will be liable – the company as the seller of defective property and the owner as the negligent contractor.
A crafty attorney will always look for an angle to make the business owner liable which is why merely protecting your business with an entity is not enough. A sound asset protection plan should include protection of all your investments so if you should find yourself on the short end of a lawsuit your risk is minimized.